1 Intelligent Well Technology: Status and Opportunities for Developing Marginal Reserves SPE
”SUBPRIME” U.S.GREEN.TECH VENTURE INVESTMENTS[
James L. Plummer, QED Research, founder IAEE, 650/321-9827,
I. Introduction
A. The year 2008 was memorable in the U.S. for the onset of a financial crisis triggered by government intervention in the residential mortgage market, and also by the election of a new president committed to government promotion of green technologies (e.g. state and perhaps national renewable power mandates, and a “cap and trade” carbon emissions regime)..
B. For purposes of this paper, technologies are grouped into five categories:
1.. “Social premium technologies”—those that have either an “oil import premium” or an “environmental premium” or both. Examples are offshore drilling, Canadian tar sands, energy conservation, LNG and GTL.
2. The subset of “Oil import substituting technologies”—those that have an “oil import premium” because they involve favourable impacts on the world oil market. Examples are nuclear power and energy conservation.
3. The subset of “Greentech”—those technologies that have a social premium because of favourable environmental impacts, such as carbon emission reduction. Examples are nuclear power and energy conservation.
4. The further subset of technologies of “subprime greentech”—those technologies that have favourable environmental impacts, but have rates of return lower than other investments, even if social shadow prices are incorporated into the calculation of the rate of return. Examples are some wind and solar technologies.
5. The further subset of “politically correct subprime greentech”—those subprime greentech technologies that are especially favored by governmental interventions, in spite of very low social rates of return. Examples are some forms of solar and wind technologies, and other technologies favored by renewable power mandates.
C. The false belief that the most politically correct greentech venture investments will have high rates of return relies partly on mistakenly concepts of “market failure”—e.g. that oil companies and other traditional corporate energy investors are either so fixated with fossil fuels or so myopic about the exhaustibility of fossil resources that they cannot recognize the better rates of return available from politically correct greentech (see Thomas Friedman, Hot, Flat, and Crowded: Why We Need a Green Revolution and How it Can Renew America, Farrar, Straus and Giroux, New York, 2008)
D. There is now occurring a huge increase in the volume of politically correct subprime greentech venture investing, both public and private, and this increase will have enormous impacts on the capital markets for energy investments.
E. Just as governmental interventions in the “subprime” residential mortgage markets caused distortions that triggered a broad financial crisis, so also could massive governmental interventions cause wasteful allocations of resources in energy capital markets, and alsocarry the risk of dangerous instabilities in those markets.
II. The present and future impacts of greentech venture investing on segments of the venture investment markets:
A. Governmental grant funding for basic greentech R&D. Hopefully, there will be many important positive “spillover” benefits from governmental R&D funding that stimulates private sector venture investing in greentech. However, government is now very much involved in loan programs for greentech on very favourable terms, and those programs can distort private capital markets. Tax credits for the operation of greentech technologies carry the risk of wasteful resource allocation and market instabilities.
B. Corporate venturing, private equity funds, hedge funds, and sovereign wealth funds. With some exceptions, this has been and will remain the “smart money” that is allocated mainly by market signals that are not too distorted by governmental activities.
C. Venture capital funds. This used to be “smart money,” but is not as smart anymore. The VC industry has undergone major changes in the last twenty years. Higher risk seed capital funds have largely disappeared because the limited partner sources (mainly pension funds and endowment funds) were adverse to the embarrassment of occasionally seeing very low returns from seed funds. So, more money has flowed to larger and later stage VC funds. However, these larger funds, and many new VC funds have become very clever at marketing themselves to limited partner sources as having greentech expertise and priorities. The members of pension fund boards or university endowment fund boards are proud to be involved in politically correct greentech and to publicize the public spirit they identify with those investment decisions. After all, it isn’t their money. So, we see new VC funds dedicated to battery technologies, or solar technologies, or wind technologies. Al Gore now heads a group of greentech VC funds. This fad will pass in another decade when it is recognized that these specialized VC funds are insufficiently diversified and carry even more risk than the funds previously labelled as seed funds.
D. Angel investor groups. This is the fastest growing segment of the venture investment community. There are now over 400 angel investor groups in the U.S. A large portion of the investments go to the most politically correct subprime greentech. Many of these groups are called “country club angels,” because they meet at country clubs and their members often have strong social ties. In the 1970s and 1980s, similar groups that invested in oil and gas exploration partnerships were called “country club wildcatters.” The new angel investor groups could be called “technology wildcatters.” Seasoned venture fund professionals are often amazed at the softness of the investment terms and the weak protections for the investors. State governments and universities are often involved in the creation and operation of these groups and are delighted to see the substantial flows of venture money into the most politically correct forms of greentech. If one views these wealthy individuals as people that just derive psychic income from being involved in greentech, then there may not be many broader consequences for capital markets from the losses that they are bound to incur. The aggregate money may be big, but the impact on each individual investor may be small.
III. The most politically correct greentech venture investments are “subprime” in the sense of causing substantial waste and inefficiency in the economic system.
A. The effects of governmental inventions that promote greentech investment involve their own types of “market failures” and consequent economic waste. An excellent treatment of the wastes and inefficiencies involved in state level renewable power mandates and the likely greater wastes that would accompany a federal renewable power mandate is contained in Robert J. Michaels, “A Federal Renewable Electricity Requirement: What’s Not to Like?,” Policy Analysis, No. 627, November 13, 2008, Cato Institute.
B. The governmental interventions to promote the most politically correct greentech are analogous to the governmental interventions by FREDDIE and FANNIE to promote subprime mortgages.
C. The distortions in capital markets caused by governmental promotion of greentech investment have the “perverse” effect of decreasing venture investments in other socially preferable technologies that that could have much bigger impacts in solving energy and environmental problems. This is the “opportunity cost” efficiency loss from over promotion of politically correct greentech.
D. Parts of the greentech wave of investment involve pseudo-market mechanisms—e.g. the market for offsets in state and potential federal renewable power mandates, and the tradeable credits in proposed “cap and trade” regimes. These pseudo-market mechanisms produce the illusions but not the reality of market efficiency or liquidity.
E. One way of testing the market efficiency of greentech investments is to examine whether the technologies and the operating equipment is good enough to find export markets in countries that do not have massive governmental interventions in favour of particular greentech investments. China? India? Brazil? Russia?
IV. The most politically correct greentech venture investments are also “subprime” in the sense that they have the potential to cause broader instabilities in energy and capital markets.
A. Another popular book in 2008 was David M. Smick, The World is Curved: Hidden Dangers to the Global Economy(Penguin, New York, 2008). Smick lays out how the governmentally protected market for U.S. subprime mortgages caused a snowball effect on world capital markets and that the lack of transparency in those markets meant that few people saw the destabilizing potential of those U.S. governmental interventions.
B. The current and expected governmental interventions in favor of politically correct greentech will create new financial instruments of great complexity, just like the mortgage-backed securities that accompanied the FREDDIE and FANNIE governmental interventions. These complex financial instruments may be purchased by individuals and institutions that have little appreciation for the inefficiencies and potential instability risks inherent in them.
C. If government is biased enough to encourage the creation of new “carbon markets,” and “renewable power markets,” will government be even-handed in insisting that the financial instruments that accompany those new markets have full disclosure of risks and uncertainties? Maybe, or maybe not.
D. There are probably many kinds of potential “shock events” that could destabilize the financial markets that become “overinvested” in greentech:
1. The same kinds of extreme instabilities in OPEC pricing and behaviour that we saw in 2008.
2. Scientific breakthroughs that cast doubt on the theory that limitations on carbon emissions are the most effective way of controlling climate change.
3. Scientific breakthroughs that suggest that other actions would be more effective at limiting climate change than carbon emission limitations.
4. Revolts by consumers and voters against the higher electricity costs caused by renewable power mandates
5. New large oil discoveries in non-OPEC nations
6. Widespread adoption of non-conventional fossil fuel technologies such as GTL, LNG,
7. Breakthroughs in energy conservation technologies
8. A faster revival of nuclear power
V. Conclusion As the U.S. economy and all the world’s economies struggle to climb out of a financial crisis and severe recession caused in large part by wrongheaded government intervention into capital markets, we ought to think carefully whether the massive governmental interventions now contemplated in favor of selected greentech technologies may carry the same kind of potential for resource waste and dangerous market instabilities.
METHOD AND SOURCES: In-person and phone interviews with about 100 players in various parts of the venture capital community. Apart from the two books and one article cited above, the paper will include data from the U.S. Department of Energy, the National Venture Capital Association, and Venture Economics (a division of Thomson Publishing). The paper will also reference parts of the book by Charles Kindlebergeret. al., Manias, Panics, and Crashes, Wiley, 1978.